August 19, 2022 | 14:59
Crude Oil Outlook: Clear as Mud
As we had previously cautioned, the oil market remains in a state of tremendous flux due to uncertainty surrounding the path of both global demand and supply. Indeed, fear of a global recession and the associated impact on oil demand has been the key factor that has rather suddenly driven benchmark West Texas Intermediate crude down from just over US$120/bbl in mid-June to around $90 presently. However, uncertainty over global supply (e.g., OPEC+’s production strategy, Russian crude exports, etc.) remains equally pronounced, which is why we still believe that the price of crude oil will face some more big swings in the coming months.
The baseline assumptions in the latest monthly flagship publications by OPEC and the International Energy Agency (IEA) shed light on why the oil market is likely to remain volatile and why we expect to see diverging projections by the energy forecasting community. Of prominence, the IEA is forecasting world oil demand to climb from an average of 99.7 mb/d in 2022 to 101.8 in 2023. OPEC is even more optimistic, forecasting 102.7 mb/d in 2023. Oil demand is expected to benefit from sky-high natural gas prices as the EU continues to ramp up stocks against the backdrop of a blazing hot summer. This is incentivizing gas-to-oil switching in the power generation sector, not only in Europe, but also Asia and the Middle East. Thus, neither group is factoring in a major global economic downturn, which if it were to occur, could instead result in global oil demand falling by perhaps 1-3 mb/d in 2023 based on recent global recessions (excluding the steep pandemic-driven drop in 2020). Complicating matters, China’s economy, which has been the biggest driver of new incremental global oil demand in recent years, is vulnerable to further lockdown disruptions given that its strict zero-COVID strategy remains in place.
The outlook for global oil supply remains difficult to predict though it’s worth noting that it hit a post-pandemic peak of 100.5 mb/d last month as a number of maintenance-related outages ended. Some central bankers are undoubtedly happy to see that the West’s efforts to shut in Russian oil have had limited success so far as supply has largely been rerouted to other parts of the world. Russian (crude and refined) oil exports averaged 7.4 mb/d in July (vs. 8.0 mb/d in January). As a result, Russian crude oil output (excluding refined products) remained steady at 9.8 mb/d in July, the same as in June and down a tad from 10.1 mb/d in January. However, true shut-in pressure on Russian supply may still be months away as the EU embargo on imports of Russian crude and refined products comes into full effect in February 2023. This means that roughly 2.5 mb/d of Russian oil will have to be absorbed elsewhere according to the IEA. It perhaps goes without saying, whether these barrels are shut in or not will have significant bearing on overall global oil supply.
On the flip side, the prospect for a pickup in supply elsewhere, mainly by non-Russian OPEC+ members and the U.S., remains a question mark. However, upside potential appears fairly limited in our view as many cartel members are still not meeting their monthly production quotas. OPEC+ output was 2.7 mb/d (or 1.7 mb/d excluding Russia) below the total quota in July. Key cartel members, Saudi Arabia and UAE, which have some spare capacity, appear comfortable with OPEC+’s current production strategy. Furthermore, it seems reasonable to believe that the current OPEC+ agreement, which ends this year, will be renewed, which should prevent a surge in cartel supply from coming on stream.
Meanwhile, U.S. shale producers won’t be riding to the rescue. They remain reluctant to increase production significantly due to investor demands to maintain capital discipline. U.S. crude oil production has risen 500 kb/d to 12.1 mb/d since Russia’s invasion began, well below the pre-pandemic level of 13.1 mb/d. Though the U.S. Energy Information Administration (EIA) is still projecting domestic output to climb to 13.3 mb/d by end-2023, the benefits of this potential increase will be negated by the end of the 1.0 mb/d withdrawals from the Strategic Petroleum Reserve (SPR) by year-end. Another supply-side wildcard—an Iranian nuclear deal—is back on the table following a new EU proposal. A deal could add 1.3 mb/d of new supply in short order. However, after many false starts, we still view the prospect of such a deal as a low-probability scenario.
Key Takeaway: Forecasting the price of crude oil has never been trickier as the trajectory of both global oil supply and demand remains far from certain. Nonetheless, we have trimmed our full-year 2022 forecast for WTI to US$100/bbl (previously $105) but have maintained our 2023 projection of $95.